Indemnification for the Board of Directors

By JaMonika Williams, NAFCU Regulatory Compliance Counsel

Part of a credit union’s day-to-day involves both defending itself from and the filing of lawsuits. From pursuing judgments in general district court to seeking relief from the automatic stay in federal bankruptcy court, credit unions are very familiar with the various stages and levels of litigation. Sometimes, even credit union officials find themselves individually entangled within an adversarial proceeding involving the credit union and a third party. Federally-insured credit unions have the option to choose to indemnify its officials, but that protection comes with some limitations. This article will tackle the circumstances when a credit union may indemnify credit union officials and impermissible indemnification.

What is Indemnification?

Generally, indemnification occurs when one party contractually agrees to cover the financial losses of another to the benefit of a third party. Indemnification is normally extended to employees who incur losses when working on behalf of their employers for a business-related purpose. If there is such a promise to cover legal liabilities, the employees are said to be “held harmless.”

As in any business setting, many legal scenarios arise that can trigger a credit union’s indemnification clause. Some trigger-event examples include, but aren’t limited to: board members being sued for privacy breaches; when an employee claims wrongful termination from the credit union; or a member claims their civil rights were violated by the actions of an official.

Permissible Indemnification

NCUA regulations permitfederal credit unions to indemnify their employees from litigation costs. Part 701.33(c) states that:

“A Federal credit union may indemnify its officials and current and former employees for expenses reasonably incurred in connection with judicial or administrative proceedings to which they are or may become parties by reason of the performance of their official duties.” Emphasis added.

Since a federal credit union’s indemnification policy is essentially a contractual obligation, NCUA mandates credit unions must follow the standards established by the state where the federal credit union’s principal or home office is located or by the Model Business Corporation Act. Determining which standard to follow is found in Article XVI of the model bylaws, shown below:

“Section 8. Indemnification. (a) Subject to the limitations in § 701.33(c)(5) through (c)(7) of the regulations, the credit union may elect to indemnify to the extent authorized by (check one).

[ ] Law of the State of ________:

[ ] Model Business Corporation Act:

The following individuals from any liability asserted against them and expenses reasonably incurred by them in connection with judicial or administrative proceedings to which they are or may become parties by reason of the performance of their official duties (check as appropriate).

[ ] Current officials.

[ ] Former officials.

[ ] Current employees.

[ ] Former employees.”

Further, to help alleviate the financial burden of legal proceedings, some credit unions may purchase insurance policies.

Impermissible Indemnification

NCUA forbids the indemnification of officials who incur a loss while classified as a dual employee, or perform egregious violations against their fiduciary duties. Dual employees are defined as federal credit union employees who perform work functions for another business entity by virtue of a “sharing arrangement between the federal credit union and the other entity.” An NCUA letter provides a brief example of a sharing arrangement, such as a federal credit union employee selling non-deposit investment products to members on or offsite. In practice, if the shared employee incurs a loss while working for the other entity, the federal credit union may not cover the potential litigation costs and expenses for this employee.

An official commits an egregious violation when he or she violates a member’s fundamental rights and “where the decision giving rise to the claim for indemnification is determined by a court to have constituted gross negligence, recklessness or willful misconduct. Matters affecting the fundamental rights and interests of federal credit union members include charter and share insurance conversions and terminations.” An example of these bad acts may include bribery. In practice, if a credit union official is sued or found guilty in court for accepting bribes in return for an improperly influenced business decision, the federal credit union cannot pay the court costs and fees per NCUA regulations.

Be aware that state laws may forbid indemnification for certain bad acts of federal credit union officials or employees. Credit unions that have purchased indemnification insurance may not be fully covered by these policies. It is important for a credit union to consult trusted counsel to help determine which state laws or insurance policy provisions limit indemnification. In conclusion, board members may want to familiarize themselves with the credit union’s bylaw language or any insurance policy concerning indemnification to determine the extent they are covered.